Internal Revenue Code (IRC) Section 1202 is a significant tax benefit that should be considered by those who have invested in small businesses and startups. This tax exemption allows noncorporate taxpayers who acquired qualified small business stock (QSBS) at original issuance and have held the stock for at least five years, the opportunity to take advantage of preferential tax treatment upon disposition of the QSBS. Depending on the date of acquisition, taxpayers may be eligible to exclude up to 100 percent of any gain from their taxable income, including exclusion from the alternative minimum tax (AMT) and the 3.8 percent Medicare surtax.
What Qualifies as QSBS?
The exclusion of gain under IRC Section 1202 only applies to the sale of QSBS. In general, to qualify for QSBS:
- The holder of the stock must have acquired it at original issuance from the corporation after August 10, 1993, in exchange for money, property other than stock or as compensation for services;
- The stock must be held for at least five years;
- The issuing corporation must be a subchapter C corporation other than various enumerated special purpose corporations, such as IC-DISCs, RICs, REITs and cooperatives;
- The issuing corporation’s total gross assets cannot exceed $50 million at date of issuance;
- The issuing corporation must meet an “active business requirement” during substantially all of the shareholder’s holding period; and
- The issuing corporation must not have engaged in specified redemption transactions.
Amount of Gain Exclusion
For each corporation in which the taxpayer sells QSBS, the amount of gain eligible for exclusion is limited to the greater of:
- $10 million ($5 million in the case of married individuals filing separate returns), less the amount of gain excluded by the taxpayer in earlier tax years; or
- 10x the taxpayer’s adjusted basis of the QSBS.
We’re Here to Help
Bennett Thrasher’s Tax practice can help you navigate the complexities of this benefit and assist in qualification by completing a Section 1202 Analysis. To learn more about IRC Section 1202, and to see if you meet the requirements for this exemption, contact Zack Leder or James Parks by calling 770.396.2200.